The Failure Of

Abu Taib Md. Zakaria, MPB

MASTER OF PROFESSIONAL BANKING (MPB) DEPARTMENT OF BANKING AND INSURANCE

FACULTY OF BUSINESS STUDIESUNIVERSITY OF DHAKA

Presentation on

Objective of the Presentation

This presentation aims identifying the multiple factors

which combined to produce The Royal Bank of Scotland

(RBS)’s failure. It describes the errors of judgment and

execution made by RBS executive and management, which

in combination resulted in RBS being one of the banks that

failed amid the general crisis.

Overview of RBSThe Royal Bank of Scotland (RBS) is one of the retail banking subsidiaries of The Royal Bank of Scotland Group plc, together with NatWest and Ulster Bank. And has around 700 branches, mainly in Scotland though there are branches in many larger towns and cities throughout England and Wales. 

But this bank has a history of operational disaster in the year 2008. RBS’s failure in October 2008 has imposed large costs on UK citizens. To prevent collapse the government injected £45.5bn of equity capital: that stake is now worth about £20bn.1 But this loss is only a small part of the cost resulting from the financial crisis. The larger costs arise from the recession which resulted from that crisis, within which RBS’s failure played a significant role. That recession has caused unemployment for many, losses of income and wealth for many more.

Acquisition of 2 Banks by RBS in 2000-2006

RBS Takeover of National Westminster Bank Plc in the Year 2000. RBS lead a hostile takeover of the troubled ABN AMRO.

But it was complex and risky because the market was peaking and maximum of the risk were about to turning into major losses,

In 2000 In 2006

Balance Sheet Position 304 Billion Pound 848 Billion Pound

In 2000 (Billion) In 2006 (Billion)0

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Position of RBS in 2000-2006

In 2000 In 2006

Profit 1.8 billion Pound 5.6 Billion Pound

In 2000 (Billion) In 2006 (Billion)0

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Profit

Position of RBS in the Year 2000-2006

Prior to 2007, RBS was a major player in international banking market

RBS was the Leader of leveraged finance & Property finance.

Ranked 1st in global asset backed and mortgage backed securitization

Ranked 4th in global syndicated loans

Ranked 8th is International Bond market

RBS Tier 1 Ratio Name of Banks Tier 1 Ratio

RBS 7.5%Barclays 7.7%HSBC 9.4%

The ABN AMRO acquisitionThe acquisition of ABN AMRO by a consortium led by RBS greatly increased RBS’s vulnerability. The decision to fund the acquisition primarily with debt, the majority of which was short-term, rather than equity eroded RBS’s capital adequacy and increased its reliance on short-term wholesale funding. The acquisition significantly increased RBS’s exposure to structured credit and other asset classes on which large losses were subsequently taken. In the circumstances of the crisis, its role as the leader of the consortium affected market confidence in RBS.

RBS decided to make a bid for ABN AMRO on the basis of due diligence which was inadequate in scope and depth, and which hence was inappropriate in light of the nature and scale of the acquisition and the major risks involved. This was the inevitable result of making a contested takeover, where only limited due diligence is possible. In proceeding on that basis, however, RBS’s Board does not appear to have been sufficiently sensitive to the wholly exceptional and unique importance of customer and counterparty confidence in a bank. As a result, in the Review Team’s view, the Board’s decision-making was defective at the time. RBS believed in its ability to integrate businesses successfully after the acquisition of NatWest; in the case of ABN AMRO, it underestimated the challenge of managing the risks arising from the acquisition.

Drawback of RBS while doing BusinessWeakness:

Risk appetite was greater than peersGreater reliance on prefer share than ordinary equityRBS was heavily relied on short term wholesale market for fund

sourcing.

Year 2006 Year 2003Net Borrowing Comparison 72 Billion Pound 3 Billion Pound

Net Borrowing Comaprison

£-

£50.00

£100.00

Yr-2003 bn

Yr-2006 bn

Fund Sourcing Status of RBS

RBS’s position : Just before the disaster

RBS bought risky bank (ABN AMRO) for Euro 22.6 Billion.

Funding Source was short term debt rather than capital raising .

94% shareholder voted for acquisition.

Area of losses Yr-2007-2008 Yr-2008-2010

Credit Trading 14 Billion PoundCommercial Property 10 Billion Pound

Net Credit Market Exposure of major banks

Consequences.October 2007: Royal Bank of Scotland's disastrous and ill-timed takeover of Dutch bank ABN Amro set off a chain of events which led to its eventual collapse.

December 2007: RBS eases investor fears when it reveals lower-than-expected write-downs of £1.5bn for both RBS and ABN Amro following the meltdown in the US sub-prime mortgage market. It offsets £250m of the write-downs by using its own cash reserves instead of turning to the increasingly expensive wholesale credit markets.

November 2008:The move comes as the government takes a 58% stake in the bank for £15bn as part of a mammoth capital raising. RBS was nationalized in 2008.Government injected 45.5 Billion of Pound as Equity and currently 80% owner.

Why did RBS fail?

Initially, we found complex combination of factors which led to RBS’ failure. They are

Some factors which were common to many banks and which contributed to the overall financial crisis.

Some which resulted in RBS being one of the specific firms which failed during the crisis’s failure.

Reasons behind RBS failure

The 1st reason: The Regulatory framework and

supervision, and for the management of firms.Because the poor decisions made by RBS management and Board

which made RBS highly vulnerable to failure, and the underlying

aspects of RBS’s management style, governance and culture which

may have contributed to those poor decisions;

Reasons behind RBS failure (Cont..)

The 2nd Reason : RBS’s capital position and the underlying

regulatory framework.liquidity run the firm’s capital adequacy (as well as about capital adequacy

across the banking system)

RBS chose to be lightly capitalized relative to its peers and made considerable

use of lower-quality forms of capital. The acquisition of ABN AMRO further

weakened its capital position.

Reasons behind RBS failure (Cont..)

The 3rd Reason : RBS’s liquidity positionRBS entered the crisis with extensive reliance on wholesale funding. Its

short-term wholesale funding gap was one of the largest in its peer group,

and it was more reliant on overnight funding and unsecured funding than

most of its peers. The acquisition of ABN AMRO increased its reliance

on short-term wholesale funding. liquidity were not adequate to identify

and limit this dependence, in particular RBS’s significant use of non-

sterling short-term wholesale funding. Once the crisis had started, it was

difficult for RBS to improve its liquidity position significantly.

RBS’s liquidity position,

Reasons behind RBS failure (Cont..)

The 4th Reason : Asset quality: concerns and uncertainties RBS’s balance sheet and leverage increased rapidly in the years leading up to the financial crisis, in a period of fast growth in credit extension and leverage across the banking sector. While RBS’s investment banking division, Global Banking and Markets (GBM), was the most rapidly growing area, RBS’s loan portfolio in its other divisions also expanded. Significant loan losses were subsequently suffered in many areas of business, with a particular concentration in commercial property. Indeed, impairments incurred on loans and advances eventually amounted to £32.5bn over the period 2007-10, significantly exceeding the £17.7bn of losses on credit trading activities. The full extent of those losses would not have been clear to the market in autumn 2008. However, uncertainties about the scale of future losses and concerns about asset classes held by RBS contributed to the loss of confidence in the firm at that time.

Reasons behind RBS failure (Cont..)

The 5th Reason : Losses in credit trading activities By early 2007, RBS had accumulated significant exposures containing credit risk in its trading portfolio, following its strategic decision in mid-2006 to expand its structured credit business aggressively. The acquisition of ABN AMRO increased RBS’s exposure to such assets just as credit trading activities were becoming less attractive. This increased the firm’s vulnerability to market concerns.

Structured credit markets deteriorated from spring 2007 onwards. RBS, like any others, was by then holding positions which were bound to suffer some loss. The crucial determinant of how much loss was the extent to which a firm could distribute its existing positions, or was willing to take losses earlier by hedging or closing those positions out. RBS was among the less effective banks in managing its positions through the period of decline.

Reasons behind RBS failure (Cont..)

The 6th Reason : Systemic vulnerabilities and confidence collapse.

The intensification of market uncertainties during the summer of 2008,

culminating in the acute loss of confidence following the collapse of

Lehman Brothers in September, affected all banks in some way. But those

most affected were those that were, or were perceived as being, in a worse

position, in terms of capital, liquidity or asset quality. They included RBS.

Key factors :The failure of RBS

Poor Supervision of RBS.Significant weaknesses in RBS’s capital position during the Review Period, as a result of management decisions and permitted by an inadequate regulatory capital framework;

Over-reliance on risky short-term wholesale funding;

Concerns and uncertainties about RBS’s underlying asset quality, which in turn was subject to little fundamental analysis by the FSA

Substantial losses in credit trading activities, which eroded market confidence. Both RBS’s strategy and the Financial Services Authority (FSA)’s supervisory approach underestimated how bad losses associated with structured credit might be;

The ABN AMRO acquisition, on which RBS proceeded without appropriate heed to the risks involved and with inadequate due diligence; and

An overall systemic crisis in which the banks in worse relative positions were extremely vulnerable to failure. RBS was one such bank

Key factors :The failure of RBS

Recommendation Capital Adequacy: Higher quantity and quality of capital. The Bank

companies must hold quality sufficient quantity of capital. It should increase the core capital while expanding its business operation.

Use of information and intelligence in banking supervision since Weaknesses in the processing and analysis

To increase its focus on prudential supervision, including liquidity and stress-testing since the liquidity regime was inadequate and needed to be improved.

Analysis of firms’ underlying assets and off balance sheet exposures In order to avoid a situation in future where a firm’s capital resources

are over-dependent on minority interests, the Authority should consider quantitative monitoring of firms’ dependence on minority interests as part of ongoing supervision.

Recommendation At the time of Acquisition the company should

Set up a multi-disciplinary team, including internal specialists, to assess the key risks (including, in particular, capital and liquidity risks) associated with the transaction at an early stage.

Consider the requirements and information flows imposed by the European legislation.

Coordinate with overseas regulators in cases of cross-border transactions where expectations, roles and responsibilities of each regulator are mutually agreed and understood, for example through the establishment of a Joint Liaison Committee.

The assessment of comprehensive (in particular, key prudential) information from the firm that sets out the impact of the proposed transaction; the adequacy of the combined group capital position at deal closure, taking into account financing, atforward projections, and under stressed conditions.

MASTER OF PROFESSIONAL BANKING (MPB) DEPARTMENT OF BANKING AND INSURANCE

FACULTY OF BUSINESS STUDIESUNIVERSITY OF DHAKA